June 27, 2016

Brexit Fails; So Will Trump

The “Leave the EU” campaign has won, and it doesn’t seem to be working for them. Leading “Leave” politicians made failed promises:

“Leave” promise: EU cash will go to the National Health Service. The campaign even put the promise on its big red bus: The EU costs £350 million a week, “enough to build a brand new, fully staffed … hospital every week.” Politicians repeated the promise, but after the vote, Leave leader Iain Duncan Smith said that the campaign didn’t say “all” of the money, just “a significant amount of it.” After the vote Nigel Farage, another Leave leader, said, “No I can’t [guarantee it], and I would never have made that claim.” The UK gets about half that money back for farmers’ subsidies, research grants, and infrastructure funding.

“Leave” promise: We’ll take control of the UK’s borders. The claim was that the expected immigration to fall. “Leave” leader Nigel Evans said there had been “some misunderstanding” over the Leave campaign’s position on reducing immigration and that he didn’t say it would fall. The UK won’t separate from the EU for at least two years, and the UK may have to keep borders open to EU workers to freely trade with Europe. Boris Johnson, a leading Leave campaigner and wannabe prime minister, wrote, “British people will still be able to go and work in the EU; to live; to travel; to study; to buy homes; and to settle down.” If that’s right, Europeans—including immigrants—will enjoy the same freedom of movement.

“Leave” promise #3: The economy will be fine. Anti-Remain campaigners laughed at the “Project Fear” that maintained the UK would suffer financial and economic turmoil. Yet, the pound is at the lowest level in decades, UK bank stocks collapsed, and GDP growth forecasts have been slashed. Companies are calling off investments, and markets throughout the world have gone down drastically, including the Dow Jones in the United States which lost almost 900 points in two days of trading.

“Brexit’s supporters are deluded when they argue that Britain could cherry pick what it likes about the European Union and discard the rest. Since exports to the European Union (13 percent of G.D.P. in 2014) matter much more to Britain than exports to Britain (3 percent of G.D.P. in 2014) do to the European Union, the European Union will call the shots. Other governments have every incentive to be tough, both to steal a competitive advantage and to deter others from following Britain out the door.”

Damian Carrington at The New Republic:

“The crashing financial markets will damage the huge investments needed to create a cleaner and safer environment and will dent the nation’s fast-growing green economy, one economic sector where the UK could lead.”

From a financial authority:

The aftershocks from the UK’s EU referendum results continue to persist. Last Friday saw exceptionally sharp declines in the major global equity markets, though the sharpest drops were recorded in the Italian and German equity markets, down 12.5% and 6.8% respectively, compared with 3.1% for the FTSE100 index, although UK bank stocks were ‘hammered’ on speculation as to how ‘pass porting rights’ to the EU might be affected, as well as a cut in the UK’s credit rating. The S&P500 index fell 3.6% and the US 10-year Treasury yield made a new low for the year at 1.40%.

In the currency market, the US Dollar to Japanese yen briefly dipped below the 100.00, and the Japanese authorities might be ready to intervene in order to stabilise the currency. The Chinese currency went in the other direction and made a new low for the year, with investors sensing that the Chinese authorities are set to countenance some slippage in the exchange rate to act as a shock-absorber for the economy.

Cable dropped sharply from $1.5000 to $1.3200 and continues its slide today, touching $1.3122. UK 10-year Gilt yields fell below 1.00% this morning for the first time ever. (The Bank of England was founded in 1694.)

From a political perspective, the referendum decision has divided the UK. “Remain” members of the Conservative Party want to stop Boris Johnston from being the next Prime Minister. In the opposition Labour Party, a series of resignations in protested Jeremy Corbyn’s leadership style. In Scotland, the SNP is looking to block the “Brexit” vote and call for a second independence referendum. The scope for a constitutional crisis is quite high, and the Brexit vote has exposed the fault-lines in British politics.

The Chancellor of the Exchequer, George Osborne, said this morning that Article 50 of the European Union Treaty would not be triggered until October. Article 50 lays down the terms and conditions of the negotiation process between the UK and EU and the framework for the exiting country’s future relationship with the EU. Article 50 sets a 2-year deadline on talks that can only be extended by a unanimous decision of the other 27 EU countries. Once activated, Article 50 eliminates the UK from EU decision-making at the highest level. Article 50 is concluded by the European Council, acting by a qualified majority, after obtaining consent of the European Parliament.

The EU Summit this week looks to push for very early negotiations, but it is the UK Government that has to decide when to invoke Article 50. At the moment, UK PM David Cameron remains in place until October when a new Conservative Party leader and PM are to be announced. This might be too distant a time and the pressure for an early settlement to the leadership question is likely to intensify. There is no guaranteed timetable as to how it all works out.

From the EU’s perspective, the risk is that “Brexit” contagion’ spreads to other countries and encourages voters to think of breaking away from the EU. The results of the Spanish elections (the centre-right People’s Party won with 137 seats) yesterday mitigated some of that risk, though there is a question whether the appetite for ever-increasing integration is still there.

Italy holds a constitutional referendum in October, but Italian voters might view “Brexit” as a way of expressing their view on the EU. The Italian economy has suffered a very low economic growth rate for some time, but it is the Italian banks that remain under-capitalised and have the potential to trigger another banking crisis.

Some forecasters are talking about a UK recession next year and perhaps an early cut in UK interest rates. In the Eurozone, the sharper declines in equity markets and concerns over the health of the banking system are likely to keep the European Central Bank’s accommodative monetary stance in place. However, German criticism of negative interest rates in terms of the cost to German banks and German savers is something that the ECB cannot afford to ignore.

Wider afield, the “Brexit” uncertainty gives the U.S. Fed every excuse to defer an increase in US interest rates. The key upcoming dates are the US non-farm payroll report on July 8. The Fed meetings after that are July 26-27 and September 20-21, which seems to be the last opportunity to raise rates prior to the US Presidential Election on November 8. A faltering US economy might require quantitative easing.

Why did UK voters favor “Leave”? Many of them probably didn’t even know the consequences. The two most Googled questions in the UK on the day after the vote was announced was “What does it mean to leave the EU?” and “What is the EU?” John Oliver, host of Last Week Tonight, had another funny, factual, hard-hitting piece about the vote. To the people who asked if they could change his vote, he emphatically said, “That was the f*cking vote! That was it!”

Although unlikely, Oliver might be wrong. The Brexit vote was not binding, and Members of Parliament could vote against it. Over 3.5 million UK residents have signed a petition demanding a second vote if support for either side was under 60 percent with a voter turnout under 75 percent. The turnout was about 72 percent, and the winning side had 52 percent of the vote. Scotland voted heavily to remain, and the Scotland Act 1998 requires the Scottish Parliament to approve measures that remove EU law from Scotland. The same might be true for Northern Ireland. The least likely scenario is that the EU could offer major concessions.

Yet the longer the uncertainty in a wait for the outcome, the greater the political and economic costs. The U.S. suffers from the same uncertainty as everyone waits for the outcome of the presidential election in a little more than four months with Donald Trump representing everything that the Leave campaign did—promises he cannot keep, an irrational xenophobia to turn the country white, and an untenable austerity approach toward the economy. The UK today could be the US this January.